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October 24, 2011

Summary of the Rules on Framework for Derivatives Clearing Organizations

WHAT’S THE RULE? The Commodity Futures Trading Commission proposed rules spelling out guidelines for clearinghouses, which are third-parties that guarantee an underlying trade ensuring both parties put up adequate margin in case of default.

WHY IS IT IMPORTANT? Dodd-Frank required that most derivatives be cleared and be traded on exchanges to bring transparency and oversight to an opaque $600 trillion swaps market that played a major role in the last financial crisis. Clearing trades will help prevent another scandal like the American International Group collapse. Since large amounts of risk will be concentrated in and managed by clearinghouses, their risk management operations will be critically important to avoid systemic risk. In addition, open and fair access is critical to make Dodd-Frank work. These clearinghouses have in the past been heavily influenced by large banks and have had history of shutting out smaller players who want to be members.

WHAT DID BETTER MARKETS ARGUE? We urged the commission to retain its proposal to allow access to firms that have at least $50 million in capital, which would go a long way to promoting competition and lower prices while still providing cushion to prevent a clearinghouse failure. Better Markets also recommended that stress tests the clearinghouses would be required to periodically preform must be based on scenarios that are historically unprecedented. The 2008 financial crisis proved the pitfalls for relying on historic price behaviors. We also urged the CFTC to make its reporting and disclosure requirements much stronger. For example, clearinghouses should have to immediately report if it seeks access to liquid funding because it is a critical factor if it can survive a crisis situation.

WHAT DID THE AGENCY RULE? The CFTC on Oct. 18, 2011, agreed with Better Markets and retained the $50 million threshold despite the opposition from the big clearinghouses. The commission also agreed to expand its scope for stress tests by substituting “extreme” conditions in place of “potential.” It changed the liquid funding rules, but not as far as we wanted by not requiring immediate reporting, which is essential to gathering evidence of an impending crisis. In other areas, the CFTC in its rule allowed too much discretion in its rule writing to strengthen the oversight system for clearinghouses.

Final rule

Proposed rule

Proposed rule

Proposed rule

Summaries of Rules


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